Resolving Bad Loans

The good news about the non-performing asset (NPA) crisis is that in the past two years, the Reserve Bank of India (RBI) and the government have forced public sector banks to recognise bad loans and make provisions for it.

The good news about the non-performing asset (NPA) crisis is that in the past two years, the Reserve Bank of India (RBI) and the government have forced public sector banks to recognise bad loans and make provisions for it. And the government has, in the past couple of years, tried to tackle the problem through a slew of measures, like the strategic debt restructuring mechanism (SDR), to throw out existing management and the newly enacted bankruptcy law.

Unlike in the past, no one is trying to brush the mountain of NPAs under the carpet, or turn a blind eye to the problem. In the latest economic survey, Chief Economic Advisor Arvind Subramanian devoted considerable space to the bad loans and "twin balance sheet" problem (the fact that balance sheets of both public sector banks and many of their corporate borrowers being in terrible shape).

The bad news is that despite the strenuous efforts of the RBI and finance ministry, the problem has stubbornly refused any resolution. Corporate debt restructuring mechanisms have time and again failed to revive borrowers or help get money back from loss-making clients.

Converting part of the debt into equity and taking over a company whose promoters have no money has not helped either. Banks have realised that it is easy enough to take over an asset, but difficult to run it or sell it at the price they want.

Using asset reconstruction companies (ARC) to take over some bad clients has not even made an impression on the overall gross NPA levels. ARCs have taken over a few companies, but the total numbers are minuscule when compared to the enormity of the problem. The bankruptcy law suffers from the same issue - it helps a lender close down a company and take over the asset, but it does not show the way forward to disposing off the asset to recover the money lent.

The government is mulling more steps. It might even come up with new guidelines and new policy measures in the next couple of weeks. One of the ideas tossed around has been the formation of a "bad bank" which takes over all NPAs from the banks, and then tries to dispose off them. This would leave the public sector banks with relatively healthy balance sheets. Other solutions such as pooling stressed assets and securitising them, as done in some countries, has also been mooted.

One big problem hampering the resolution of NPAs is the issue of how much haircut to take. Many of the biggest loans are not given by a single bank, but by a consortium of banks, each with different exposures according to their risk-taking abilities and balance sheet sizes. Resolution requires the majority of them agreeing to a particular solution - which is often hard to get when six or seven banks with different priorities are involved.

Then there is the worry that if the banks try to get rid of a really bad asset by selling it at any price they get, and taking a steep haircut, they can be hauled up by the CVC, the CAG or the CBI at a later date. No bank chairman relishes the prospect of being put in prison long after retirement for trying to solve a problem proactively. They would rather take no steps and pass on the problem to their successor. There are also proposals to strengthen the existing resolution mechanisms like SDR or S4A by more oversight committees and flexible joint lenders' forum to take decisions.

Any solution the government works out needs to solve those problems. And also incentivise public sector bank chairmen to take quick decisions about resolving each NPA, rather than worry about being blamed in the future.